Now that the malaysian regulatory issues have subsided, there...

Now that the malaysian regulatory issues have subsided, there are two key risks facing LYC investors:

(1) Technical issues that stop LAMP operating at phase 1 full capacity (=11kt per annum) from next quarter onwards. This risk also speaks to management competence: their ability to anticipate technical issues, communicate them to the market in a timely manner, and properly fix said issues in the timeline that they have outlined, and within current capex expectations.

(2) RE prices falling to unprofitable levels (or, expected production costs proving unrealistic and rising to unprofitable levels).

With respect to (1), I don't think the market will give LYC the benefit of any doubt. I.e., the market will not price in LAMP running at nameplate capacity until it actually is reliably running at nameplate capacity. And I don't think we are going to get a definitive answer to this question until the next quarterly conference call, and after management is subjected to much hard questioning (including from myself).

I've already spoken about (2) in recent posts. However, to summarise, the relevant basket price for LYC product presently sits at around US$30/kg, with rising momentum. 'All in' production costs, following recent guidance, should be around US$20-21/kg once phase I is operating at full capacity. ('All in' costs include operating costs, corporate overheads, royalty payments, interest payments, and sustaining CAPEX). So, roughly speaking, if present prices are maintained, LYC will be generate pre-tax profit of around US$10/kg once phase I is running properly. And because of accumulated tax losses in Aust, and the tax holiday in Malaysia, I'd expect LYC to be paying effectively zero tax on earnings for the next 3 years (depends, of course, on the quantum of earnings).

So for FY14, if LYC can produce at nameplate for 3 quarters (given that the current quarter, like the last, is largely being used to replace piping etc), and if $30 basket price holds over FY14, NPAT should come in at around $82mill. This is well above the expectation of most analysts, and (I suspect) many punters on this thread, but if the risks outlined in (1) and (2) don't come to pass, mathematics dictates that it is a realistic expectation nevertheless.

Given that the Chinese are finally clamping down in a forceful and comprehensive way on black market RE production and sales, and given rising REO demand in Japan, Korea, the US, and modestly rising demand in the EU and domestically in China, I think a US$40/kg basket price is not unrealistic for FY15. A $40 basket price roughly translates into an NPAT figure of around $220mill for FY15 (again, assuming that virtually no tax is payable).

For FY16, I think it is realistic to assume that global REO demand will be sufficient for phase II to come on line (all analyst reports that I've read also make this assumption; and virtually every expert commentator expects heavy RE demand to significantly outstrip supply by 2016), which will cause LYC production costs to fall from $20/kg to around $15/kg (as reiterated in the last conference call). Assuming a $40 basket price, tax credits/holiday, this translates into a rough NPAT figure of around $550mill. (Even at a $30 basket price, phase II should see LYC generating profits in the region of $330mill).

How will all this play out in terms of the share price? First, the NPV/DCF-derived price targets that most analysts cite mean diddly-squat in this market. It is my expectation that once the market is satisfied that phase I will reliably operate at full capacity going forward, it will start to value LYC loosely on 1 year forward PE metrics.

If (1) and (2) fall LYC's way, then using my assumptions above, the company is presently trading on an FY14pe of around 9.5, an FY15pe of around 3.4, and an FY16pe of around 1.4. Assuming the market values LYC on a PE of around 14, this suggests that LYC will rerate to around 60c as soon as the market believes that phase 1 is operating at nameplate, $1.50 next year, and around $3.90 once the market is convinced that phase II will come online. (Re potential dilution going forward, I simply note that the company presently has no plans to raise capital – whether it needs to or not over the medium-long term will obviously depend in large part on (1) and (2)).

Another note I made after listening to the conference call is that because key Japanese customers are still undertaking quality control on most of the high value REO, even if LAMP was operating at full capacity at present, they wouldn't be able to sell the high value stuff to key Japanese customers. So, while the effective LAMP shutdown is regrettable, the opportunity cost for the shutdown is not as great as I think most people have assumed. In effect, as luck would have it, the anticipated timing of the end of the current maintenance/pipe upgrade will coincide with the end of the Japanese quality control process and the first high volume orders.

Summing up, I think one can cautiously say that the ducks are finally starting to fall into line for LYC. Regulatory risk is now effectively gone. REO prices have upward momentum again (and with considerable structural pressure to continue to rise over the medium and long term). LAMP technical risk/management competence risk certainly remains; but the next quarterly should give clarity on that front. If LAMP is confirmed to be operating at full capacity at the next quarterly call, I think LYC will quickly rerate to around 60c. And, given the assumptions I have sketched above, it is not at all difficult to see LYC trading north of $1 in around 12 months.